Investing 101

INVESTING 101

I'm often asked if I will manage my clients' money. The answer is no, for a number of reasons:

I believe strongly in the entire financial plan. History shows that the actual selection of individual stocks and bonds is not nearly as important as asset allocation and how the entire plan works together - income, investment, and spending. We won't invest for you directly, but we will figure out your best asset allocation.

There are many ways to successfully invest and build a portfolio. I am a very strong believer in just one method, which I detail below. I'm not sure I'd be acting in the best interests of all my clients if I only used this one technique (even it has been very successful).

As my senior citizenship looms, I don't have a yearning for hundreds of panicked phone calls from clients when the market is down. (If you're currently freaking out about the market, read this.)

I'm not a licensed broker, so while I can give advice, I cannot actually take over the funds and invest them.

That being said, I have a long history of successful investment management and a solid philosophy of what works and what doesn't (backed by empirical evidence). Under the heading of "putting my mouth where my money is", I will share these theories and actual practices with you in the posts below. These are not necessarily recommendations on my part, but it is an overview of the process that I do use for managing my own and my family's investments.

Well, not everything but certainly all the fundamentals. Here is my primer on investing in four charts.

Don't be afraid to invest. If you keep all your savings in cash, you might sleep well at night. But you might wake up 20 years from now and realize that your money, in terms of spending power, is only worth 1/2 to 1/3 of where it started out. This chart shows what happens if you keep all your money in cash compared to the growth of investing in the other major asset categories.

Be patient. Your returns are not going to come easily, quickly, or necessarily consistently. However, as this chart shows, over time your average returns will certainly show a degree of consistency and growth if you remain patient.

Asset Allocation. Strict asset allocation has been the foundation of successful investing for decades. No one can predict which asset classes will go up in any year nor the degree of growth (or loss). But if you follow a strict asset allocation model, you'll always be "buying low" and "selling high". This chart illustrates how hard it is to predict in advance the performance of each asset class, which is why asset allocation (and diversification) is so important.

Stay Invested. Don't try to time the market and don't bail out at the first sign of a downturn. In today's world of instant news and stock market volatility, most investment gains come over a very small number of days, as displayed in this chart, and if you "miss" those days, you could affect your returns for years to come.

Hopefully, you are now really excited and ready to read on! But if not, you likely have the fundamentals that you need.

I follow a simple and very rigid asset allocation model. A fairly long but readable introduction to asset allocation can be found here. Based on my own tolerance for risk along with my needs for income and capital growth, I have set a specific allocation as follows:

Fixed Income

48%

US Equity

24%

Canadian Equity

18%

Foreign Equity - EAFE

3%

Foreign Equity - Emerging Markets

2%

Real Estate

5%

I rebalance each quarter to these exact numbers. I do not time the market. Within a few days of the quarter-end, I re-calculate my asset allocation and promptly rebalance.

If I purchase a stock during a quarter, I sell an equal amount of another stock to keep the allocation intact.

The fixed income portion of the portfolio is simply a ten year laddered bond portfolio, with 10% of the portfolio reaching maturity in each of the next ten years. When a bond reaches maturity, subject to rebalancing the entire portfolio, the proceeds are simply re-invested in a new bond maturing in 10 years. I tend to hold all bonds to maturity unless I have to sell in order to maintain my asset allocation. This way, I really am not subject to fluctuations in bond prices, and also get to average my fixed income investments at differing interest rates. I tend to purchase mainly provincial and municipal bonds, with some high grade corporate bonds also in the mix.

The equity portion of the portfolio is invested in conservative, generally dividend paying stocks. About half are U.S. stocks. My detailed equity portfolio is outlined below.

The foreign stock portion are generally ETFs focusing on a particular non-North American region.

I attribute 80% or more of my investment return to this rigorous rebalancing. It has not always been easy (1987 market crash, 1997 Asian crisis, 2000 internet crash, September 11th, 2008 financial crisis), but it has always turned out well (in the longer run).

I like to purchase individual stocks, but I'm not convinced that they necessarily out-perform market index Exchange Traded Funds ( ETFs) or low-cost mutual funds. I enjoy doing research on companies, as I've spent much of my business career evaluating businesses. It does take work, though.

That being said, I don't disagree with Warren Buffet's advice to his wife on how to invest his billions upon his passing:

"My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors – whether pension funds, institutions or individuals – who employ high-fee managers."

I am somewhat intrigued by the recent emergence of "Robo Advisors", in that they follow a very strict asset allocation model using low-cost ETFs. I have put a small amount of my assets into one of them, Wealthsimple, and I will write about the performance as I start seeing measurable results.

If it does not pay a dividend, there has to be a VERY good reason to buy the stock. Read this excellent article on dividend investing to learn more.

I prefer companies with recurring revenues (such as pharmaceuticals, Starbucks) as opposed to manufacturers and companies where products are purchased sporadically.

I favor companies that take advantage of a major demographic trend (such as Baby Boomers).

In spite of spending most of my life in technology, I don't purchase very many technology stocks. I own a smattering (Apple, Google), but they tend to be underweighted. Technology moves too quickly for me and owning a technology stock might violate my first rule above.

I invest first and foremost for total return over my lifetime as opposed to tax-advantages in the short term. In other words, I let my overall investment strategy set my course. Once I set my strategy, I do aim for tax benefits, but it never drives my decisions. I see too many clients investing for short term tax advantages, to the detriment of their long-term wealth building. For example, many of my Canadian clients have upwards of 90-100% of their equities in the Canadian market, due to the tax benefits of Canadian dividends. Yet they are missing out on significant gains (and diversification) by ignoring the U.S. and global markets.

The portion of my assets that are in equities are ALWAYS 100% invested in the market. See the chart on this page for an explanation why.

I never have more than 5% of my investible assets in any one stock or bond.

I normally buy equal amounts of all holdings except for my "speculative" stocks, which are very small amounts.

My speculative stocks, if any, make up less than 2% of my liquid assets. I currently hold some shares in a private, alternative energy company.

My bonds are high-grade provincial, municipal, and corporate bonds. I never chase yield, in that the reason I hold bonds is for safety and preservation of capital. I have never had a bond holding default.

I keep my fees low. I use a discount broker and simply pay $9.99/trade. For managed accounts, I try to keep my clients' cost well under 1% of total assets under management, and closer to 0.50% is preferred. In a low interest environment like we have been in for years, you simply cannot afford either direct or hidden fees of 2% or more as you are likely to end up losing money after taxes and inflation.

My portfolio as of January 5, 2017 is shown below. The year that I first purchased my current holding is displayed, followed by the overall investment return since the stock was purchased, and then the current dividend yield (if any) is shown. The Canadian side is up a cumulative 100%, while the US side is up 105% (in US dollars - in Canadian dollars it is up close to 140%). None of this is really brilliant stock selection - rather it is simply "sticking with the plan". The effect of being a buyer when stocks were way down in 2008 is still evident in the portfolio. I will update this from time to time.

NOTE: the % yield shown is the current yield. The actual yield that I am receiving on my original investment is often much greater. For example, while the TD Bank yields 3.3%, I have owned the stock for so long and it has risen so much since my original purchase that I am yielding more than 11% on my original cost. Many of my stocks are yielding over 10% on the original cost, and this will only keep going up. THIS SHOWS THE POWER OF PURCHASING SOLID, DIVIDEND PAYING STOCKS, AND SIMPLY HOLDING ONTO THEM FOREVER!

Symbol

Security

Year Purchased

% Gain

% Yield

CANADIAN STOCKS

BCE

BCE Inc.

2009

119%

4.7%

BLX

Boralex

2017

0%

3.2%

BAM-A

Brookfield Asset Management

2002

604%

1.6%

CM

Canadian Imperial Bank of Commerce

2009

67%

4.4%

CNR

Canadian National Railway

2016

11%

1.7%

EMA

Emera Incorporated

2015

4%

4.6%

SU

Suncor Energy Inc.

2002

110%

2.6%

BNS

The Bank of Nova Scotia

2001

130%

3.9%

TRI

Thomson Reuters Corp

2013

65%

3.1%

TD

Toronto Dominion Bank

1998

287%

3.3%

TRP

TransCanada Corporation

2003

105%

3.7%

US STOCKS

MMM

3M Company

2009

190%

2.5%

GOOG

Alphabet Inc. (Google)

2008

331%

AAPL

Apple Inc

2012

101%

2.0%

JNJ

Johnson & Johnson

2008

91%

2.8%

PAYX

Paychex Inc.

2009

126%

3.0%

PFE

Pfizer Inc.

2009

104%

3.9%

PMD

Psychemedics Corporation

2016

76%

2.5%

SCI

Service Corporation International

2009

533%

1.8%

SBUX

Starbucks

2015

33%

1.8%

PG

The Procter & Gamble Company

2009

47%

3.2%

UL

Unilever PLC

2008

32%

3.5%

VZ

Verizon Communications

2016

15%

4.2%

WM

Waste Management Inc.

2008

137%

2.4%

REAL ESTATE INVESTMENT TRUSTS

AVB

Avalonbay Communities

2009

123%

3.1%

DLR

Digital Realty Trust

2013

121%

3.5%

O

Realty Income Corporation

2015

31%

4.2%

WRE

Washington Real Estate Investment Trust

2011

30%

3.7%

FOREIGN STOCKS

XEF

iShares MSCI EAFE

2017

0%

2.1%

EEM

iShares MSCI Emerging Markets Fund

2008

5%

1.9%

My Canadian stocks are all very conservative, dividend paying companies. I take advantage of the dividend tax credit that favors Canadian dividends. My U.S. holdings are more diversified, and while there is no advantageous dividend tax treatment, I have benefited from the overall rise in the U.S. market as well as the rise of the U.S. dollar. All in all, my U.S. stocks have significantly outperformed my Canadian holdings. The only non-dividend paying stock is Google. Google is one of my "necessary" technology buys.